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On Central Banking
- Jan Fredrik Qvigstad
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- 05 July 2016
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- 30 June 2016
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In these six lectures given at the Norwegian Royal Academy of Science and Letters, Jan Qvigstad draws on his deep experience at Norges Bank to outline key principles on which to base central bank policy. The first two lectures (Keeping promises and Transparency) emphasize the importance of credibility and ensuring accountability. Lectures 3-6 can be viewed as applying these key principles to specific issues (Making good decisions; Managing wealth; Learning from history; and Institutions). The lectures do not break new ground - indeed, Qvigstad nicely illustrates how these principles have been articulated in literature, history and politics. Rather, the lectures emphasize the lessons to be drawn by applying these principles to central banking history with primary reference to the case of Norway, such as managing Norway's sovereign wealth fund and designing institutions that will produce good policy outcomes.
6 - On Institutions: Fundamentals of Confidence and Trust
- Jan Fredrik Qvigstad
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- On Central Banking
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- 05 July 2016
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- 30 June 2016, pp 156-190
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Summary
Institutions
The concept institution has many meanings. For example, there is an important distinction between its meaning as an abstract concept and as a concrete one. The judicial system in Norway is an institution in an abstract sense, while the Supreme Court is concrete. The Norwegian National Opera and Ballet is a concrete cultural institution within our more abstract cultural heritage. In my own field, the monetary system is abstract whereas Norges Bank is concrete.
I would like to speak about the role institutions can play in the economic advancement of a nation and use the central bank as an example. My co-speakers will view the issue from different perspectives and the ensuing debate will bring forth yet further aspects.
Good institutions provide sound frameworks that increase confidence and promote economic progress. This is so in relation to minor, everyday situations as well as to major life choices. At the fishmonger's, the Norwegian Metrology Service ensures that you pay for the actual weight of your cod fillet. When you buy a home, clarity about ownership and encumbrances is ensured by the land register. The Norwegian Industrial Property Office grants patents so that entrepreneurs can make profits on their innovations. In the absence of such institutions, each of us would have had to spend more time on taking precautions and fewer investments would have been profitable.
However, in and of themselves, institutions are insufficient to ensure progress – the key is whether they are strong or weak. This is also the starting point for Daron Acemoglu and James Robinson's book Why Nations Fail. They introduced the concepts of inclusive and extractive institutions.
• Inclusive institutions do not forget why they exist: they remember that their purpose is to serve the people, as the term “public servant” aptly illustrates. A well-functioning constitutional state makes cooperation and transactions simpler and cheaper.
• Extractive institutions, on the other hand, are found in countries where rulers govern without notable opposition, where the judicial system is not fair, and where rights are not equal for all.
The authors refer to several examples where people groups with identical backgrounds and access to the same natural resources have developed differently because of institutional differences.
This leads to a key question: what are the principles that underlie those institutions that actually fulfill their role and effectively serve society?
3 - On Making Good Decisions
- Jan Fredrik Qvigstad
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- On Central Banking
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- 05 July 2016
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- 30 June 2016, pp 67-96
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Summary
Introduction
When Hans Rasmus Astrup was appointed minister in Johan Sverdrup's government in 1885, he sold his business in Stockholm and moved back to Norway. As I mentioned in my lecture here two years ago, Astrup was at the time perhaps Norway's wealthiest man. On his return to Norway, he needed a place to live, bought a plot of land here in Drammensveien, and decided to build the house we are sitting in now.
The question might be raised whether it was a good decision to build such a large and ostentatious house. But Astrup was not just looking for a home for his family. The house was also intended to provide a venue for interdisciplinary and political discussions.
We all make many decisions every single day, some more important than others. And we all presumably want these decisions to be good ones. But how can we ensure that a decision is good? This is a weighty and far-reaching question. If I am to make meaningful contribution, I will need to limit my focus.
Norges Bank makes many decisions. The monetary policy decisions every six weeks are awaited with particular interest. Based on my experience from interest rate decision making, I will focus on how the quality of a decision can be assessed. Even though I am speaking from my own perspective, I hope I am able to touch on more general issues that are of wider relevance.
Independence Provides a Sound Framework for Interest Rate Decisions
Most countries have now delegated the task of ensuring price stability to the central bank. This is also the case in Norway. The government has set an inflation target for monetary policy and delegated the operational conduct of monetary policy to Norges Bank.
This framework can be regarded as an institutional solution to the problem of avoiding major mistakes. An independent central bank is better able to give priority to long-term interests over short-term gains.
That it is tempting, but dangerous, for a government to focus on short-term gains was a lesson Greek politicians learned in 2010. Government spending exceeded revenues over a long period. Accounts and official statistics were fudged.
4 - On Managing Wealth
- Jan Fredrik Qvigstad
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- On Central Banking
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- 05 July 2016
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- 30 June 2016, pp 97-123
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Summary
Introduction
From Norges Bank we can see the corner of the two streets, Tollbugaten and Kirkegaten. This is where the Collett building was situated until 1939 when it was dismantled and moved to the Norwegian Museum of Cultural History at Bygdøy. By then, the Collett family had not occupied the building for years and their wealth was long gone.
Around the end of the eighteenth century, John Collett made a large fortune in the timber industry. He also ran the great Ullevål farm and by the time of his death in 1810 he was managing one of the country's largest wealth portfolios. Collett was also known to spend extravagant amounts on lavish parties. The Napoleonic Wars and the English blockade took a heavy toll on the family business. After his death, Collett's heirs insisted on maintaining an extravagant lifestyle as if the income was still intact. Their wealth rapidly withered away and in 1829 the coffers were empty. The farm was taken over by the state.
The time it took Collett to make a fortune is about the same as it took Norway to build up its oil-based financial wealth. Nearly forty years after Phillips Petroleum discovered commercially viable oil reserves in the Ekofisk field, we have an oil-based sovereign wealth fund worth more than NOK 3 trillion. Few other countries are sitting on such huge financial reserves. But our wealth primarily comes from other sources than the oil fund, now called the Government Pension Fund Global. The value of our current and future labor resources is more than ten times as great as the value of our oil and the oil fund combined. The oil fund would be depleted in three years if government tax revenues were to disappear entirely.
Our economic future depends above all on our capacity to produce goods and services that others value. But the visible oil revenues may give the impression that we have a huge treasure trove at our disposal. Sound wealth management is therefore first and foremost a question of maintaining and developing the value of our productive resources, particularly our labor resources.
Dedication
- Jan Fredrik Qvigstad
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- On Central Banking
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- 30 June 2016, pp vii-viii
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1 - On Keeping Promises
- Jan Fredrik Qvigstad
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- On Central Banking
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- 05 July 2016
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- 30 June 2016, pp 1-31
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Why Is Keeping Promises So Difficult?
This house, which now belongs to the Norwegian Academy of Science and Letters, was built by Hans Rasmus Astrup in 1886–1887. Astrup was an entrepreneur. At the age of 20, he left Norway for Barcelona on a ship laden with a cargo of dried cod. He gradually built up a large trading business and later became an industrialist, not unlike businessmen of our own era.
For innovators and the business sector, a stable operating environment has always been important, providing a foundation for adaptation, economic growth, and social progress. A stable value of money is also a component of this foundation.
We were taught as children to keep our promises. If we made a promise, we had to make good on it. But we were also taught that we should not promise too much. If we do not keep our word, others lose confidence in us and our credibility takes a toll. In recent months, we have witnessed that this is of particular importance for the financial system. A proximate example is the situation in our neighboring country Iceland.
The value of confidence and credibility has been the subject of extensive analysis in many fields, including jurisprudence and the social sciences. And the conclusion is clear – progress can be achieved if promises are kept.
If keeping promises is clearly beneficial, why is it then so difficult? The expressions “empty promises” and “empty threats” reflect the temptation to renege. The social scientist and philosopher Jon Elster writes in his book Ulysses and the Sirens about weakness of will, shifting preferences over time, and the complexities of human nature. This is familiar ground. As early as 1960, the economist Thomas Schelling discussed similar issues in analyses for which he was awarded the Nobel Prize in economics. According to Schelling, a credible threat can be difficult to establish when realizing the threat involves costs for all the parties involved. A promise or a threat will be more credible if the promisor lets himself be bound to the mast.
Two other economists carried out groundbreaking work when they applied Schelling's analysis to economic issues.
Miscellaneous Endmatter
- Jan Fredrik Qvigstad
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- On Central Banking
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- 05 July 2016
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- 30 June 2016, pp 207-207
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Frontmatter
- Jan Fredrik Qvigstad
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- On Central Banking
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- 05 July 2016
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- 30 June 2016, pp i-vi
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Contents
- Jan Fredrik Qvigstad
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- On Central Banking
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- 30 June 2016, pp ix-x
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2 - On Transparency
- Jan Fredrik Qvigstad
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- On Central Banking
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- 05 July 2016
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- 30 June 2016, pp 32-66
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Summary
Introduction
Norges Bank's Executive Board has decided that the key policy rate now should be 1.5 percent. If economic developments are broadly in line with projections, the appropriate key policy rate will be 2.75 percent around the end of next year.
If I had made this statement ten years ago, it would have constituted a breach of confidentiality. Norges Bank considered this to be highly sensitive information. Had I been deputy chairman of the U.S. Federal Reserve Board twenty years ago, I would not even have been entitled to reveal the latest interest rate decision. Today, this sounds rather odd. Transparency is now taken for granted among central banks and in other areas of society.
In London in 1780, the Bank of England was put to a test. In Parliament, Lord Gorden attempted to stop a bill to restore civil rights to Catholics. He drew support from large numbers. Rioting led to the destruction of several public buildings. When an attack was launched against the Bank of England, the building was secured like a fortress and withstood the onslaught, hence the phrase “as safe as the Bank of England.” Through the years, the phrase has been simplified into “as safe as the bank.” As banks and central banks store gold and money in their vaults, their edifices have always been solid, protected by thick walls. In a figurative sense, it might be said that a safe and credible national monetary value relied for a long time on thick central bank walls insulating its internal workings from the general public.
Until our time, central banks have been closed, both physically and figuratively. Central banks were shrouded in an aura of mystique, which they probably had a hand in perpetuating. Central bank governors worldwide refrained from saying too much, and what they did say often sounded cryptic.
In Norway, monetary policy was probably also perceived by many as something mysterious and remote. In the Festschrift for former Norges Bank governor Hermod Skånland, Professor Preben Munthe writes the following:
There is a tradition that expects central bank governors to be parsimonious with words. This built up the aura that should surround a man in that position. He possessed knowledge about the secret black box – monetary policy with a capital M – and how it functioned.
5 - On Learning from History: Truths and Eternal Truths
- Jan Fredrik Qvigstad
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- On Central Banking
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- 30 June 2016, pp 124-155
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Introduction
All scientific and scholarly disciplines have a particular, and not immutable, set of truths. Mathematics and theology are possible exceptions, though for different reasons. As the late Professor Knut Sydsæter underscored when assisting me with this speech, in mathematics new results are proved on the basis of fundamental axioms and become new truths. Theology also relies on truths, even eternal truths. Even if logical proofs of God's existence have long been an important pursuit, it is safe to say that the truths in theology today stem from faith.
The discipline of economics can readily be formulated in the language of mathematics, and economic models are usually tested empirically before gaining acceptance. Conflicts arise when theories that appear to be patently true are unsupported by empirical evidence, or when contradictory theories find support at the same time. In other words, we economists are in a borderland between faith and the strict proofs of mathematics.
The notion of learning from history cannot easily be explored without invoking the American physicist Thomas Kuhn. This year is the fiftieth anniversary of the publication of his groundbreaking work, The Structure of Scientific Revolutions. According to Kuhn, disciplines progress within an established set of truths – a paradigm. Observations irreconcilable with the paradigm are tolerated as inexplicable. Eventually, however, the number of inexplicable observations can become so overwhelming that the paradigm breaks down. New truths have to be established – a paradigm shift occurs.
Such shifts can be painful. The old paradigm will usually be defended by those whose training lies in a more distant past, often persons in positions of leadership in academia and government bureaucracy.
Long before Kuhn, Henrik Ibsen touched upon the same idea in An Enemy of the People. Doctor Stockmann talks about the few who attain the new truths, unlike the compact majority that have yet to embrace them.
Social scientists, like economists, face some peculiar problems when attempting to learn from history. First, we do not have a laboratory in which we can perform experiments. Second, economic policy is part of the reality we observe. The outcome of a particular measure will depend both on shifting economic conditions and on economic agents’ expectations of the effect of that measure. It goes without saying that in a situation like that, drawing useful lessons from history can be a challenge.
About the Authors
- Jan Fredrik Qvigstad
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- On Central Banking
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- 05 July 2016
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- 30 June 2016, pp 191-194
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Index
- Jan Fredrik Qvigstad
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- On Central Banking
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- 30 June 2016, pp 195-206
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Preface
- Jan Fredrik Qvigstad
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- On Central Banking
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- 05 July 2016
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- 30 June 2016, pp xxix-xxxiv
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“Money makes the world go around,” they sing in the musical Cabaret. The musical is dark and melancholic. The song's message is that money makes the world go around; not love, not having children and grandchildren – just money.
As economists we think otherwise. We think that money is not an end in itself. Money is the oil in the machinery that helps the economy to function. We think of money as the unit of account, just like distance is a unit of measurement. It would be meaningless to answer the question “How far is it?” with 110. One must add the unit of measurement, “yards” or “meters.” Money is useful as means of payment so that one can avoid returning to a barter economy. Money is also a store of value, creating a time gap between earning and spending to allow borrowing in the meantime, which facilitates investment. Money, however, only functions in an efficient way if there is trust and confidence. In early times money circulated in the form of coins, with a promised content of silver, copper, or gold. It was tempting to debase the coins and reduce or replace some of the silver with less valuable metals. When paper money came into use in the form of banknotes, it was tempting to produce too many of them, until their value depreciated and they could no longer be exchanged into the promised silver or gold content. Since the mid-nineteenth century, money has mainly been in the form of bank deposits. Trust is still critical, not least our trust in banks. As the economy develops and grows more sophisticated, so does money. In a modern society, it is inconceivable for the world to go around without money. Modern societies have delegated the task of safekeeping money to central banks.
On Central Banking contains six lectures given at the Norwegian Academy of Science and Letters. The lectures analyze different aspects of central banking but the questions raised could also be relevant for other institutions in society. The key words are trust and confidence.